A precious metal is a rare, naturally occurring metallic chemical element of high economic value. Historically, precious metals were important as currency, but are now regarded mainly as investment and industrial commodities. The demand for precious metals is driven not only by their practical use, but also by their role as investments and a store of value. Historically, precious metals have commanded much higher prices than common industrial metals. While not limiting the present invention, the four major precious metals, as generally understood in the global market, are gold, silver, platinum, and palladium; three of these metals serve as the primary investible assets for investors wanting to buy/sell precious metals: gold, silver, and platinum.
Precious metals have historically served as a recommended component within a diversified investment portfolio. These physical assets are associated as a store of wealth; inflation and currency hedge; and for art, jewelry manufacturing and industrial use. Precious metals are an internationally traded commodity, and trading in precious metals has existed globally for thousands of years. Currently, there are international exchanges that exist to facilitate a mechanism for price discovery and trade in precious metals. The major trading centers for the precious metals are the Hong Kong Mercantile Exchange, the Dubai Gold & Commodities Exchange, the London Metal Exchange, and the COMEX division of the New York Mercantile Exchange.
One unique characteristic of physical precious metals investing is that the owner of such metals is capable of realistically having direct ownership of the investment. This is typically not the case for other major commodity investments, such as oil, wheat, pork bellies, etc. However, even though an individual investor could take possession of the physical precious metals, there are still custody, storage, and security elements associated with possession of precious metals.
Many of the financial instruments created over the last several decades were centered on equities and fixed income instruments. One large segment of advanced financial products centered on providing investors instant and easy diversification within a particular asset class. These products would have a regularly published trading price that provided the investor an easy way to track and trade their investment. Such products flourished in various forms, such as for example equity mutual funds, fixed income mutual funds, Real Estate Investment Trusts (REITs), etc.
Likewise, there have been attempts to develop a number of direct and indirect vehicles for investors to participate in the precious metals markets. The following are the most widely used methods for investing in precious metals for both institutional and individual investors; however, each suffers from significant drawbacks.
Direct ownership of physical precious metals is straightforward, as the investor is directly purchasing and therefore gains title to the metal. Advantages are full and unencumbered ownership, the elimination of counterparty risk, portability of the asset, liquidity, global acceptance of the asset, and direct price discovery. Drawbacks include varying premium costs over spot prices for retail investors, depending on what form in which the precious metal is fabricated; custody arrangements; storage costs; theft protection; and, for investors who have taken personal possession of the items (removed the precious metals from a dealer storage account), getting the items back into the market for sale and/or trade. Also, taking physical delivery of certain precious metal bars, thus removing them from a recognized and exchange-approved depository, breaks the chain of custody. Breaking the change of custody may require the owner to pay for an assay of the metals if and when they sell the metals and subsequently must return them to a depository.
Another vehicle is pool accounts. A pool account is, in effect, a precious metal account in which a client owns a defined, un-segmented interest or portion in a pool of precious metal held in storage at the dealer's facility. The precious metals dealer takes funds from the investor and owes the investor a quantity of metal equal to the amount originally purchased. The dealer is not compelled to, and in most cases does not, purchase the metal to secure the customer's purchase. Because this is basically a loan to a dealer, with a promise to repay based on the value of the metal at time of redemption, the premium the dealer charges over the spot price of the metal is very low, but the investor is taking on a lot of risk. Since the customer gains no title to any precious metals as security for the invested funds, should the dealer become insolvent, the investor is viewed simply as a creditor.
Shares in mining concerns are widely used by investors as a proxy play on the precious metals market. Advantages are that the shares are quoted and traded on major equity exchanges. Disadvantages include mining shares are not a direct investment into precious metals, the shares do not move in value in direct proportion to changes in the pricing of precious metals, and mining shares carry the counterparty risks associated with an operating company. Additionally, share prices can be affected by market conditions which are not indicative of the operational condition of the company.
Exchange Traded Funds (ETF's) and Exchange Traded Products (ETP's) are investment funds traded on exchanges, much like stocks. With the precious metals ETF's/ETP's a trust is created that issues shares representing ownership interest in the trust. The stated objective of the trust is to track the price of the underlying metal. The investor does not have direct ownership of the underlying metal. As to the holdings of the trust, metal is reported to be held in both allocated and unallocated accounts. The investor is charged a quarterly management fee to cover administrative and storage costs. The primary allure of these funds are ease of trade, and the ability to trade fractional increments of the metal, as the shares are generally priced to represent a fraction of an ounce (for example, gold is generally quoted and purchased in ounces; the shares of the SPYDR Gold Trust ETF (GLD) offered by State Street Global Markets, LLC, One Lincoln Street, Floor 30, Boston, Mass. 02111 represent 1/10th of an ounce).
Drawbacks associated with most such trust vehicles include those associated with general counterparty risk when an entity and financial instrument is placed between an investor and the underlying asset. Such risks include the trust's lack of control at their custodians and sub-custodians, elevated risk compared to metal held in an allocated account, elevated risk to any portion of the trust's holding which are in unallocated accounts, and failure of the fund or trust managers to execute their fiduciaries duties. Additionally, the typical retail or small institutional investor is not provided with the ability to convert, in a reasonable and efficient way, the purchased shares into actual physical metals for delivery.
For example, among the risks associated with the SPYDR Gold Trust ETF (GLD) discussed in its Prospectus (available at http://www.spdrgoldshares.com/media/GLD/file/SPDRGoldTrustProspectus.pdf (accessed 15 Mar. 2011)) are the following:
“The Shares may trade at a price which is at, above or below the NAV [Net Asset Value] per Share and any discount or premium in the trading price relative to the NAV per Share may widen as a result of non-concurrent trading hours between the COMEX division of the New York Mercantile Exchange, or the COMEX, and the NYSE Arca.”
“The sale of gold by the Trust to pay expenses will reduce the amount of gold represented by each Share on an ongoing basis irrespective of whether the trading price of the Shares rises or falls in response to changes in the price of gold.”
“The sale of the Trust's gold to pay expenses at a time of low gold prices could adversely affect the value of the Shares.”
“Purchasing activity in the gold market associated with the delivery of gold bullion to the Trust in exchange for Baskets may cause a temporary increase in the price of gold. This increase may adversely affect an investment in the Shares.”
“Shareholders do not have the protections associated with ownership of shares in an investment company registered under the Investment Company Act of 1940 or the protections afforded by the CEA [Commodities Exchange Act].”
“The Trust may be required to terminate and liquidate at a time that is disadvantageous to Shareholders.”
“Redemption orders are subject to postponement, suspension or rejection by the Trustee under certain circumstances.”
“Redemption orders are subject to postponement, suspension or rejection by the Trustee under certain circumstances.”
“Shareholders do not have the rights enjoyed by investors in certain other vehicles.”
“When the seven year fee reduction period terminates or expires, the estimated ordinary expenses payable by the Trust may increase, thus reducing the [net asset value] of the Trust more rapidly and adversely affecting an investment in the Shares.”
“[T]he Trustee may have no right to visit the premises of any subcustodian for the purposes of examining the Trust's gold bars or any records maintained by the subcustodian, and no subcustodian will be obligated to cooperate in any review the Trustee may wish to conduct of the facilities, procedures, records or creditworthiness of such subcustodian.”
“In issuing Baskets, the Trustee relies on certain information received from the Custodian which is subject to confirmation after the Trustee has relied on the information. If such information turns out to be incorrect, Baskets may be issued in exchange for an amount of gold which is more or less than the amount of gold which is required to be deposited with the Trust.”
“The Trust's obligation to reimburse the Marketing Agent, the Authorized Participants and certain parties connected with its initial public offering of 2,300,000 Shares for certain liabilities in the event the Sponsor fails to indemnify such parties could adversely affect an investment in the Shares.”
“Gold held in the Trust's unallocated gold account and any Authorized Participant's unallocated gold account will not be segregated from the Custodian's assets. If the Custodian becomes insolvent, its assets may not be adequate to satisfy a claim by the Trust or any Authorized Participant.”
In addition, in existing offerings a customer can purchase amounts of a precious metal in quantities that are not priced in round ounces or equal to the amount of an available fabricated quantity, such as a kilo bar, 100 oz bar, etc. These types of offerings are specific to one metal and are most similar to a precious metal purchase that generates a warehouse receipt. A warehouse receipt represents direct ownership of a quantity of the purchased metal. The purchase may be secured by a percentage ownership of a larger bar. Such offerings are made available by firms such as GoldMoney Inc., and have been made available by Neptune Global Holdings LLC, Wilmington, Del. 19801 since 2004.
An expanded description of such an offering from Neptune is as follows (available at http://www.neptuneglobal.com/files/Vault_Account_Info_Oct2010v2.pdf (accessed 15 Mar. 2011)): “Vault Account is an account whereby clients own a defined quantity of a precious metal(s). The precious metal(s) representing the holdings of Vault Account clients are consolidated and stored in Neptune's master allocated account at a recognized bullion depository. Client holdings (a defined quantity) are secured by precious metals, but not to a specific bar(s) and/or coin(s). The client has the option to convert Vault Account holdings into bullion for delivery in the form of any type bar or coin normally carried by Neptune upon payment of quoted fabrication charges.”
It would therefore be beneficial to an investor, to offer an investment product that marries the benefits of direct ownership of physical precious metals, a more efficient and democratic delivery option of the investment for small investors, the elimination of a ‘paper’ proxy substituting as direct ownership, the elimination of a third-party trust entity for the ownership and associated management of the metal between the investor and the underlying metal, and an efficient diversification characteristic affording ease of trade and real-time pricing capabilities. Such an investment product should further provide ease of trade, real time price quoting, and a degree of investment diversification within the precious metals spectrum.